"Will Buying Options Affect Stock Price?"

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"Will Buying Options Affect Stock Price?"

"I've looked at all the option Greeks & how options are affected by movements in the underlying stock/ETF but how do options affect the underlying? For example, if a trader buys a large quantity of OTM calls, does this affect the underlying price?"
- Asked By Ken Malcolm on 10 Oct 2011

Answered by Mr. OppiE

Hi Ken,

Indeed, stock options prices are affected most by changes in the price of the underlying stock since they are derivatives of stocks. However, does this relationship work the other way round in options trading? Does strong buying of options affect the price of the underlying stock in any way? This is an extremely interesting question indeed.

Now, when you buy an option, you are really only entering into a contract for the POTENTIAL trading of the underlying asset itself. This means that when an option is purchased, nothing really happens to its underlying asset at all since the buyer and the seller that got into the options contract hadn't commenced any form of trading of the underlying asset yet. Yes, this means that when you buy stock options, nothing really happens to the underlying stock yet since the right to trade the underlying stock given by the option has not yet been exercised, and it could even never be exercised. This is why these contracts are known as "OPTIONS" and not "OBLIGATIONS" like futures trading are. Options give you the "RIGHT" but not the "OBLIGATION" to trade the underlying asset at the strike price, remember?

So, what happens to the price of a stock when someone buys a huge quantity of its out of the money call options?

ANSWER: Nothing.

Nothing happens because an out of the money call option grants the buyer the right to buy the underlying stock at a HIGHER price, which is something almost nobody will exercise on. On top of that, the out of the money call options may remain out of the money all the way to expiration and simply "Expire out of the money" like it never existed in the first place. So, why should the price of the underlying stock be affected by something that could jolly well never have existed at all, see?

Now, stock price CAN be momentarily affected by an option when the option is exercised.

If by expiration those out of the money call options becomes in the money and is exercised, the price of the stock would momentarily sink to the strike price of the call options and then almost instantly get back up to market price as market makers and market participants continue to bid and ask at market prices. In fact, this momentary sinking only happens when a HUGE amount of call options at the same strike price are exercised. This effect is hardly noticable if only small numbers of options contracts are exercised. This is also why trading volumes are so high on Quadruple Witching days when options and futures are exercised and settled for the underlying stocks. In fact, this effect is noticable only on Quadruple Witching days and are barely noticable during options only expiration.

In conclusion, buying options don't ever affect stock prices but exercising options at a single strike price on a huge number of contracts might cause some momentary price change which usually returns to market price in an instant.